Simon Cope-Thompson draws on a wealth of experience to share a practical guide to best-practice negotiation with private equity firms.
Having worked in the world of M&A and private equity (PE) for over 25 years, I’ve dealt with hundreds of different firms from around the world, and met, worked with and negotiated against (and sometimes for) thousands of individuals following globally recognised negotiation-skills certification courses working within these institutions. Most of my career has been spent acting for entrepreneurs and business owners (both private shareholders and larger corporations) and it’s fair to say that most of them start off with a relatively negative view about PE investors and a general distrust about how they will behave both during and after a deal. They have heard war stories passed down directly from friends or other business owners about unjustified chips to the price or other changes to the key commercial structure of a deal that emerge at the last minute.
It would be wrong for me to pretend this doesn’t happen today and I’m not here to defend the indefensible. There are firms (and individuals working within those firms) who have a well-earned reputation for some pretty poor negotiation behavior and deal antics. However, this is not as commonplace as it was a decade or so ago. In my experience, the PE market has (largely) changed – it’s had to.
Against this backdrop and with the caveat that every PE deal and process is different, I have compiled a key list of “must dos” to help you prepare for and execute any negotiation with a PE counterparty.
CHOOSE THE RIGHT ADVISERS — AND THE RIGHT NEGOTIATION TRAINING PARTNER
Clearly, I can’t be expected to be completely unbiased here with this first piece of advice, but the sale of a company or stake to a PE firm is a complex process. Having the right set of experienced advisers—and, ideally, a specialist negotiation consultancy such as The Gap Partnership running a focused negotiation workshop—alongside you who know the tricks of the trade, possess the skills to deal with some uniquely technical financial issues, and have dealt with the firms and individuals you are negotiating with, will ultimately enhance your chances of getting the best deal.
Over the last five years it has become increasingly rare for successful business owners not to be advised on a deal by both a financial adviser and a corporate lawyer. Both have a range of invaluable experience and insight into the way PE counterparties might operate during a process. It’s important to choose the right advisers to sit alongside your team. Make sure they have good knowledge of your sector, the investors that are most interested in it, and the negotiation courses or masterclasses that can accelerate deal outcomes.
Although some PE firms might try and encourage a seller to agree a deal without speaking to a financial adviser, you have to ask yourself why they would be doing this – more often than not it’s with an eye to getting a better deal for themselves or ensuring that the adviser doesn’t broaden the process. However, most appreciate the role that an experienced adviser plays, and the help and guidance they bring to the table, and frequently encourage a vendor to appoint someone to help.
BE CLEAR ON YOUR OWN OBJECTIVES (AND AGREE YOUR “RED LINES”)
Like any other form of negotiation—and as every Gap Partnership masterclass emphasises—you have to know what you’re looking to achieve out of a deal with a PE investor before commencing negotiations. It’s not always straightforward as the shape of a transaction and what you are looking to get out of it can vary enormously, and may evolve as the process progresses. Sellers who are looking to cash out 100% may have different objectives from a transaction than those looking to stay involved and partner alongside a PE firm going forward. This will impact how both sides approach the negotiation.
If you’re looking for a clean break, then achieving the highest price from the sale is likely to be your number one priority. The PE firm is a buyer, you are a seller and the lines are drawn. Sellers need to agree what their walk-away price is (along with any other commercial terms) and be prepared to stick to it.
If you’re staying on as a shareholder, and particularly if you are part of the ongoing management team they are backing, this will have some bearing on how both sides manage the negotiation, as ensuring that the ongoing relationship between the parties is preserved will be important.
BE WELL PREPARED … AND THEN DELIVER THE RESULTS
PE firms are extremely demanding in terms of the information they expect to receive on a company before they finally conclude whether or not to invest. They also rely upon a broad range of diligence experts (financial, legal, commercial, political, IT etc) to scrutinize the data and report back.
Being well prepared up front is a key element to delivering a successful sale process. Although it doesn’t happen on every deal, there has been a growing trend for sellers to prepare their own diligence (Vendor Due Diligence or VDD) ahead of starting a sale process, and to make sure this is supportive of the key commercial messages and financial information contained within any marketing materials or the financial model/business plan. VDD protects against hidden surprises that could otherwise come out at the last minute and give the investor the opportunity to renegotiate. As a process unfolds and negotiations develop, it’s critically important to try and deliver strong results and positive trading information, building momentum and delivering good news to investors.
CHOOSING THE RIGHT PE FIRM – DO YOUR DILIGENCE ON THEM
PE firms operate within a highly sophisticated multi-trillion dollar global industry, where they’re not only competing for the very best deals but also for access to the best investors for their next funds.
PE investors are financial buyers that purchase businesses as an investment and are primarily concerned about their anticipated investment returns: this has several consequences. The final purchase price they are prepared to pay will be largely driven by the anticipated financial performance that they model from the investment and how this impacts the key ratios that their fund performance (and individual rewards) are measured by.
A track record of strong absolute and relative financial returns is a critical benchmark as PE investors try to differentiate themselves from their peers. However, it is worth bearing in mind that in order to raise their next fund, they have to invest (and then successfully realize) their current one.
PE funds typically have a ten-year duration and the fund’s life cycle has a powerful effect on the motivations of the PE firm. The investment rationale or expectations behind the first deal in a fund can often be different to the one which triggers the threshold for their next fundraising to start; the pressure for returns in a fund that has already realized market leading returns are different to one that is underperforming.
Alongside financial performance, PE firms’ reputations have also become an increasingly important differentiator for both sellers looking to choose who to transact with, and funders deciding which firms to invest behind. Many PE firms have established a reputation for a specific style of institutionalized DNA which depict their brand in the market. However, just like every other business in the world, each PE firm is made up of a group of individuals. They bring their own negotiation styles and experiences (and often a pressure to perform relative to their colleagues) each time they try and do a deal.
COMPETITIVE TENSION
If they can engineer it, PE firms will always prefer to negotiate one-on-one with a seller outside of a sale process. They understandably feel that not only does this enhance their chance of success if they aren’t competing with another firm, but also that outside an auction they have more opportunity to negotiate better terms.
Over the past 18 months we have seen an increased number of pre-emptive deals with PE investors that are making unsolicited approaches to targets. In some cases, firms hear that a seller is looking to kick off a broader auction process and move quickly to close down the process by making them an offer they find hard to refuse. Sellers are often seduced by the headline price and the promise that they can get an accelerated deal closed. However, the sellers are often not ready for the subsequent diligence process and end up exposed when a PE firm tries to change agreed terms late in the day. Our advice to sellers is that if they are looking to negotiate a preemptive deal, you have to be willing to walk away, regroup and talk to others. The threat of this alone (if real) can be enough to create the competitive tension you need to keep the buyer honest.
However, more often than not, sellers decide to test the market and run a process which involves approaching more than one investor (as well as potentially strategic buyers). Running a competitive process does not automatically give a seller a stronger hand in the negotiations; ultimately this will depend on how a process unfolds. Over the past few years there has been a strong demand for the very best assets, and this has definitely led to it being much more of a sellers’ market. Although PE investors will compete hard for something they really want, sellers and their advisers need to find the right balance as there are definite risks from “over-selling.” Working out which participants are genuinely interested and will last the distance is critical as the last thing you want to find is that bidders drop away and you are left with a broken process where you have to go back to under-bidders with your tail between your legs.
NORMAL AND CUSTOMARY
One of the most common complaints from sellers is that it is far too easy for a PE firm to hide behind the claim that a particular legal point is “the market norm” or “entirely customary.” The fact that a particular term has been negotiated on each of an investor’s last five deals doesn’t mean that you have to accept it (or that it’s fair!) Make sure your advisers—and your negotiation-training provider—are able to fully explain why the terms are there, what they mean and why they might be acceptable (or how to trade them).
PE investors represent a growing proportion of the global M&A marketplace. They are very likely to represent one of the strategic options for you as you consider your optimum exit strategy. PE firms want to invest the money they have raised, backing strong management teams and achieving an excellent financial return. To do this they have to complete deals. If you are well prepared with strong advisers around you, a clear set of objectives, thorough homework on suitable investors, and crucially an asset that investors are going to want to compete for, there is nothing to fear.
About the author
Simon Cope-Thompson is Managing Director at Arrowpoint Advisory, the mid-market advisory arm of Rothschild & Co, and an alumnus of The Gap Partnership’s Senior Negotiator Certification, where he has spent the past 30 years advising on M&A, debt, and special situations. Based in London, he works with a wide range of clients—from listed and private companies to entrepreneurs and investors—delivering strategic financial solutions that leverage Arrowpoint’s deep sector expertise and Rothschild’s global reach. With a proven track record across three decades, Simon is a trusted advisor in complex transactions and high-stakes corporate finance.
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